Oct 17, 2015

The Drought’s Impact on California Housing

California has been dealing with the drought for several years now but the lack of rainfall has done little to derail the housing recovery. A water shortage has led to government-mandated water restrictions with Gov. Jerry Brown imposing a 25% cut on water consumption. While this may be impacting agricultural production and social aspects of life such as watering your lawn or washing your car, data indicates that it has not adversely impacted housing activity. The housing market and overall economy throughout the state is the healthiest it has been in over seven years. There is robust job growth from as far south as San Diego all the way up the coast to the Bay Area. We took a look at some housing indicators along with doing a study on water costs to analyze exactly what the drought has meant for housing and what if might mean, if anything, going forward.

To date, the drought has not done anything to stop builders from building. Building permits this year are on pace to reach their highest levels since 2008 while rising for a sixth consecutive year. According to data from Zonda, total residential building permit activity is up almost 4% from a year ago on a seasonally adjusted basis. Even in agriculture-heavy areas in the Central Valley, building permits are up. Sacramento has seen total residential permit activity increase almost 30% in the first half of this year compared to the same period last year. Permits were up almost 64% during that same timeframe for Fresno and were roughly flat compared to a year ago in Stockton. Builders remain very active due to positive economic trends and historically low mortgage rates. This should continue to be the case in the near term as homebuyers try to get in before the Fed raises rates later this year or early next year.

Kevin Gillen, Chief Economist at Meyers Research LLC, recently did a study on how the drought may affect housing and analyzed housing outcomes through water utility costs. Data for all three metrics of water costs were collected along with annual rainfall totals for the 30 largest cities in the U.S. along with some additional ones in California. The results of the study found that the relationship between rainfall and water costs is relatively weak and that rainfall only accounts for 3.6% of variation in the cost for water across all these cities. Ironically, cities with high rainfall totals also suffer from high water costs due to increased expenses associated with removing water: directing runoff, flood control and processing wastewater. Overall, the study found that the most expensive city for water alone was Santa Fe while the most expensive cities for water, sewer, and stormwater management combined were Atlanta and (ironically) Seattle, primarily due to significant water infrastructure projects currently being constructed there. Also unexpectedly, cities with among the lowest overall costs of water included Las Vegas, Phoenix, Bakersfield and Fresno.

However, once the cost of water has been partitioned into the cost of delivery versus the cost of removal and processing, a very different picture emerges. As con be observed in the below chart, cities with very little rainfall have total water budgets where resources are primarily devoted to the delivery—as opposed to the removal—of water:

California’s housing recovery has shown to be very resilient thus far. Beyond the ongoing drought, California also faced labor disputes that shut down local ports and continue to face lower crude oil prices which are making it difficult on alternative energy companies. In the near term, there is no reason to believe that demand should not remain relatively strong. But, unless the longer term sees either a return to normal rainfall levels or increased levels of infrastructure to improve water delivery and storage capacity, then a permanently higher cost of water will likely lead to increased city density, smaller average house sizes, decreased housing affordability and eventually, lower-than-otherwise homebuilding levels.